The prohibition on short selling by the Ontario Securities Commission in September 2008 significantly impacted market quality by boosting both volatility and price spreads, a study by the Investment Industry Regulatory Organization of Canada has found.

The study, called “Report on the Impact of the Prohibition on the Short Sale of Inter-listed Financial Sector Issuers,” was undertaken at the request of the Canadian Securities Administrators. Its purpose was to examine the impact on trading activity of the OSC’s order prohibiting short sales of certain financial sector issuers.

The IIROC study found that the order, issued Sept. 19, 2008, appeared to have a significant impact on market quality. Specifically, it significantly increased volatility among securities generally—not just among the prohibited issuers. The order also reduced available liquidity and increased the spreads between closing bid and ask prices, the study found.

However, the study also found that there was also no appreciable difference between changes in prices of restricted financials and those financial issuers for which short selling was permitted.

In addition, the study shows that prior to the introduction of the prohibition, short selling activity in the restricted financials was generally consistent with historic levels of short selling for inter-listed securities. This was despite the fact that there were unusual levels of trading activity in financial sector issuers immediately preceding the issuance of the order, according to the study.

A second study released by IIROC on Wednesday, entitled “Recent Trends in Trading Activity, Short Sales and Failed Trades,” examines the relation between short sales and failed trades over a 17-month period in 2007 and 2008.

It shows that the Canadian marketplace did not experience problems with abusive short selling and naked short selling that the United States or other jurisdictions may have experienced.

The studies are part of IIROC’s activity in monitoring trading on equity marketplaces in Canada, and ensuring that rules for market integrity are informed by relevant and timely data.

“We constantly monitor marketplace trends,” said Susan Wolburgh Jenah, IIROC president and CEO. “We responded to the recent market turmoil by heightening our surveillance activities, with an emphasis on short selling.”

IE